Abstract
This paper examines how asymmetries between partners in the ability to appropriate the returns from collaboration affect governance choices and investment patterns. We consider multiple pairs of upstream and downstream firms, where firms must collaborate to improve product components. We show that when there are significant initial asymmetries in appropriability, components are easily redeployable and market size is sufficiently large for asymmetries to be exploited, then there exists a Pareto-inferior equilibrium where unstructured collaboration between independent firms breaks down. As a result, some pairs may be better off formalizing their relationship or integrating. All organizational forms (unstructured and structured partnerships, and integration) can co-exist in equilibrium, despite all pairs being identical ex ante and facing the same environment. The relationship is symbiotic: more hierarchical modes of governance exert a positive externality over less hierarchical modes, which allows the latter to be sustained.
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